Motley Fool Hidden Gems Investing - Redfin On The Attack

Episode Date: August 27, 2023

Real estate is always a tough business to be in, but especially right now.  Redfin is trying to meet customers on multiple fronts from studio apartment rentals to selling $5 million homes.  Glenn Kelman has been CEO of Redfin since 2005 guiding the real estate technology company through a variety of transitions, taking the company public in 2017 and plenty of market cycles along the way.  Deidre Woollard sat down with Glenn to discuss: - The challenges of the current real estate market. - How Redfin plans to take share in the luxury space.  - What value  two recent acquisitions have added to the business. Companies discussed: RDFN Host: Deidre Woollard Guest: Glenn Kelman Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

I probably call two or three high-end customers every weekend just to reassure them that the CEO of the company cares about the sale of their home, that we know that we're not the longest-standing luxury brand, and that just means we have to try harder. I'm Deidre Willard, and that's Glenn Kelman, the CEO of Redfin, a company that is at the forefront of real estate disruption. May have seen the company's ads on television or spotted its for sale signs in your neighborhood. At least Glenn hopes you have. In our interview, we chatted about what it'll take to get more homes on the market, Redfin's new tests with agents, and the success of some recent acquisitions.

I'm excited to talk to you because you have weathered so many tough times in the real estate market. Exactly. Exactly. We're in one now that is interesting. What are some of the similarities and some of the differences from what you've seen before? Well, I was the CEO of Redfin in 2008 when the great financial crisis destroyed the global economy. The difference this time is that people are not selling homes short, we're not going through foreclosures, and may take longer as a result because there is such an inventory shortage in the U.S. right now. So many people are sitting on two and a half, three percent mortgages, and they're not going

to sell for a decade or more. So home prices collapsed in 2008, but not this time. The only thing that has collapsed is sales volume, which of course is most important to Redfin or any other real estate broker. I think the other change, of course, is that we are a public company. We're operating at a larger scale. And so we're going through these wild ups and downs in public with everyone able to see all the transformation that we've gone through. But long term, I just believe that this will leave us as a stronger company. We were growing too fast in 2021 and 2022, just trying to keep up with a pandemic-crazed housing market. And now I think we're in a better position to take share, both online when we compete against Realtor.com, Homes.com,

Zillow.com, and as a brokerage when we compete against Remax or Keller Williams or Compass. Yeah. It's definitely an interesting time. What you mentioned with the inventory, I read a stat that said about 91% of the mortgages are under 5%. People don't have that incentive to move. Like you said, it's probably not going to change anytime soon. Is there anything that you think could change that? Is there a chance that mortgage rates drop lower than we're forecasting and expecting? Well, not in 2023. My expectation is that rates will stay above 7% for the balance of the year. At some point in 2024, we can hope that the Federal Reserve will ease on interest rates and that mortgages will come down. There are

long-term reasons that we may not see a 3% mortgage again, but just going down to 5% would make a huge difference for consumers. One of the most striking aspects of the housing market this year. It's just how rate sensitive buyers have been. When rates come down just a little bit, the buyers immediately come out of the woodwork and start looking at houses again. And even going from 6.9 percent to seven and a quarter, those buyers step back. So that is probably the most important change is just what the Federal Reserve does to interest rates. And maybe the other is that over time, there's just pent up demand where because housing is a basic need, people do need to move. They go through deaths in the family, divorces, they relocate, they just want a different

life. And they can put that off for six months or 12 months, but not forever. And so we'll be there when they need us. At this point, though, there doesn't seem to be much room for sales volume to decline farther than it is at around 4.1, 4.2 million units. Maybe it goes to 4 million units, but then you'd really be far outside of any historical norm, even when the population was 10, 15% smaller a decade ago. I want to talk about something new that you're trying at Redfin. You talked about a little bit on the earnings call. I find it's really interesting. So you're testing out this new strategy in Los Angeles and San Francisco, and you said you're giving the lion's share of the commission on self-sourced sales, but you're keeping more of the commission

on the Redfin sourced sales. So I have to know, what does lion's share mean in terms of the commission? And is your goal here that you're basically recruiting the top performers from other brokerages? Yeah, well, the goal is to just be very acquisitive about talent, because I think every traditional brokerage has been hoping that Redfin wouldn't offer people a compelling commission split for self-sourced sales. And now we really don't make agents choose between that high split for self-sourced sales and the other major asset that they want, which is access to more customers. And so giving agents the best of both worlds should let us recruit more agents and should let us recruit top-notch agents, which is especially

important in some of these luxury markets where the median home price is above a million dollars. We haven't worked out the exact commission split. I actually wrote that line about the lion's share, and it was hard for me to write because I think Rudyard Kipling actually believes the lion's share is 100%, that there's one percentage because a lion is the king of the jungle, and then there's another percent, which is just the lion is the lion, and he can kill any other animal that he wants. And so it's not going to be 100%. But generally, the splits and traditional brokerages are somewhere between 60 and 80%, depending on an agent's tenure. And our goal is to be competitive there. So that if you say, well, I've got six or seven deals that

I think I can close on my own, and I still want to make money from those. But I also feel like I could do double that or triple that if i were working with redfin we want you to be able to do that without worrying about the trade-offs well and that's interesting too because i used to work in real estate brokerages actually in los angeles and uh yeah and so i saw a lot of agents that would come to the brokerage that i was working at luxury brokerage would come from redfin after a couple of years because they'd learned so much and so they would be these fantastic agents but they would move on as they sort of evolve so is that part of what your strategy is here it is historically our troubles with agent attrition have been limited to agents who

are fairly new to redfin where we've been able to recruit people who are new to the industry some of them work out some of them don't once an agent has established herself is successful at Redfin, our attrition rates are extremely low. LA is an example of a market where that wasn't the case. And part of it may have been just the culture of our LA market and the leadership that we've had there. Part of it might be the home prices are just so high in LA and San Francisco that agents just do the math about what they could make at a traditional broker. So that's why we're trying it in those two markets. Retaining top agents has always been important to us, and we should do better there in these coastal markets. It hasn't been the No. 1

priority elsewhere, because mostly, retention rates have been really good for high-producing Redfin agents. I've noticed that Redfin is capturing more of the luxury share. I'm in Alexandria, Virginia now, and I've seen more Redfin signs on some beautiful high-end homes. So is that also part of the strategy here? It is. So Redfin really has been a middle-class phenomenon, and housing has increasingly become a luxury good.

So we've always done well at $500,000 to $1 million homes. And now most homes in some of these coastal markets are above that price. So we need to figure out a different way to appeal to luxury customers. Some of that is more individualized service, and some of that is just a different profile of agent. But we have been doing better,

even with the talent that we have today. There are many great agents working at Redfin, and some of it is just changing the website to reassure customers that if you work with us and you're trying to sell a $5 million house, we are going to move heaven and earth to get that home sold. So I probably called two or three high-end customers

every weekend just to reassure them that the CEO of the company cares about the sale of their home, that we know that we're not the longest-standing luxury brand, and that just means we have to try harder. We're gonna put their home on the homepage of our website. Every single person in sales management

is gonna be involved to make sure that we never miss a beat. it's just going to be an all-out effort to go at the high end. We're starting from almost nothing there. Two, $3 million homes. We have a very tiny fraction of the market, but that is growing really fast. We feel like we're on the attack, which is always exciting. It is. One of the services that you've talked about before from the high-end market is the Redfin Concierge. The idea that you could prepare a home for market with all of the updates, all the staging, take that sort of out of the seller's hands. How is that working now? Is that still something that you're putting a lot of effort for? It's good. It's just hard to scale.

So being a general contractor is a hard, low-margin business. But getting a house fixed up and selling it for top dollar is a really lucrative business. So what we found is that there are a small number of updates that when you perform them really well, have an incredible return on investment, both for the homeowner and the broker. So overwhelmingly, our concierge customers are very happy. They feel like we've done something that other brokers couldn't do by owning these renovations, being the general contractor, having all the bills come to us, and then taking the cost of that out of escrow instead of making the customer pay up front. the challenge is just doing that well for 10,000 homes and not just 500 or 1,000 every quarter or

whatever the number might be. So we're looking at ways to delight customers with a concierge service that's easier to scale. I think that's the simplest way to describe the conundrum is it's a great service, but we want to offer it to more people. Interesting. Yeah, it is hard to scale updates and things like that. Yeah, yeah. Well, it's just also hard to get it done in two or three weeks. You've got to put in a new lawn and paint the walls and tear up the carpet and update it. I think, though, the intellectual property we've developed over time, we used to do the most dingbat, oversized renovations where there was no way the customer could get her money back. And now we know exactly how to modernize a home and just put new knobs on the cabinets and a new type of hose in the sink to have it look like it's not from the 1980s, but it's from the current decade.

And that can cost only a few hundred or thousand bucks, but it still makes $10,000, $20,000 worth of difference in the sale price. The kitchen looks modern. So is that one of the lessons you got from the iBuying experiment? Somewhat. But iBuying was generally lower-priced homes, so we were fixing up three $400,000 homes, and here we're doing $1 million, $2 million homes. So not all of the lessons transfer, but many of them do. When we were first doing iBuying, we were over-renovating homes,

and it just feels different when you're the one. And it shouldn't feel different, but it does when you are the one paying to over-renovate it. So often now I'll talk to customers who say, my home isn't selling. I want another open house. I want another mailer. And I just hearken back to my experience when we owned the asset, when we were the seller of the property and the agent. We never thought that way. We just thought we either need to invest in the property or lower the price.

and that's given us more standing when we talk to our customers about what's really going to make a difference. And usually since people don't want to lower their price, we need to make the house look better. Right now, there are only three types of sales. You know, which bucket do you want your listing to be? Number one, you can be the sexiest house on the block.

Number two, you can be the cheapest. Number three, you can be the one that sits there forever. And nobody wants to be number three. Usually you don't want to be number two either. So let's go sexy. I love that. Well, I wanted to also chat with you about your use of partner agents. With Redfin, I've been watching this.

These are the agents that aren't the Redfin agents. They get referrals from your site. This has sort of added some optionality and flexibility. So you said on the call you're ramping up use of partner agents. I think it was from 37% to 55%. Over a couple of years. Yeah. Is this going to be a static number over time, or do you think that's going to expand and contract with the market?

Oh, well, it will definitely expand and contract with the market. So it is impossible to have fixed cost agents with mid margins in a highly cyclical seasonal business. So it's worthwhile to try to have fixed costs where you invest in the salary and the benefits for your agents, in part because you want to be a good employer, a good partner to the agents and recruit the best talent. but in part because it also gives you the standing to have a higher margin than most brokerages most brokerages have single digit operating margins and i think we can do better but you just left high and dry when the market recedes and you employ too many people it's why we had two layoffs over the course of 2022 and so now we're trying to build a more resilient business by sending more demand to partners so that when there is a demand shortfall

the partners feel it before our employees do. And it used to be that when a third of demand was going to partners, we thought we were safe. But it turns out that there are swings in the market that are more violent than that. And so giving ourselves more cushion is helpful, but it also lets our employees focus on the most lucrative listings where there's just a higher margin. If you're trying to make money as a broker selling homes in the rural parts of Washington State, where it might be mobile homes trading for $80,000 a year, there's just not much margin in that. But if you can focus your employees on million, $2 million homes, there is. So I think there's a bunch of reasons that moving to a more partner-driven model actually not only drives the

business in the obvious way, but also makes the employee business more lucrative. And just what's been painful about doing that this year is usually you bring more demand to yourself when there's a housing downturn. And instead, what we've done is say, even in this downturn, we want to rebalance the business and get to a place where partners are handling about half the demand. And so that partner business, it sounds like it varies across different markets, right? So you'll be having more employees in some markets and less in others? That's true too. So there are some markets where we just don't have the density of demand. So our website traffic might be very low in Alabama and we might be more partner driven there because

if you're generating one or two opportunities per month, that's not enough to sustain an employee, but it is enough to sustain a partner and especially when that demand is less lucrative it makes more sense to use a partner so we still depend either way on whether we get a closing because we're not being paid up front for the introduction instead the partner pays us at closing when that introduction leads to an actual sale and that means that it's just really important for us to use everything we've learned running our employee business to make our partner business work, because there's all sorts of shenanigans you can play on a website to get more people to ask to meet an agent, and many of them might not be serious.

And so that looks like it'll be an increase in revenue, but actually it's just incredibly wasteful of an agent's time and ultimately destructive for shareholders because we're paying that agent. And I think partners appreciate that experience because they know that we work with our inquiries as employees. That means the inquiries have to be good. And Redfin, you know, especially my experience in Los Angeles was that people love the app. All of the, you know, it didn't matter if the brokerage had its own app. The Redfin experience was so much better.

And so as you keep driving traffic to the website and to the app, what things are you thinking about that might make it more appealing as time goes on? Are you thinking about different types of home tours or incorporating AI? What are you looking at? Well, there are two main initiatives. One is artificial intelligence, and the other is the integration of agents' expertise into the online experience. And so we already use artificial intelligence for our estimate to estimate what a home is worth. I think it's the most accurate in the industry. We also use it for recommendations where we suggest homes that you might like.

It turns out that our suggestions are often better than the search results you asked for. So people are more likely to want to tour and even buy a home that we've suggested than to see a home that they've asked to see. And so those recommendations have been really successful. And sometimes it leads to these really fun results where people will say, oh, you know, you're suggesting that I move to San Diego. I had no intention of moving to San Diego. And then we say, you ought to talk to your wife. She's been browsing there. That's why we sent you a suggestion.

But obviously now with large language models, there's exciting new ways to answer more real estate questions. and we can use that technology to improve the online search experience, but also to make the labor-driven part of the business more efficient. So my hope is that we can guide people through the whole home buying process better using artificial intelligence. But our other challenge is just to make vertical integration pay for the people using our site. Most of the people using Redfin.com have no idea that we handle the whole transaction, that we have agents hosting tours and writing offers and listing properties, but all of that expertise, if it is going to be housed on the same roof with the company making the website, ought to show up on the website. And so

our goal would be just to take what agents learn walking through houses and writing offers and guiding people through the process to say, here are my favorite homes in Venice. Here's what I think houses are really trading for right now. This is an example of something that I've never seen before that just happened. Our agents send a lot of emails like that out to their customers, but everybody should be able to see it. So, I think it'll make our site more compelling in the search indexes, like Google and Microsoft, so that we rank higher and get more traffic. But I also think it'll just be better for the people using the site. So, that's the hope. Those are the main two strategies to make the search experience better.

So thinking about that other aspect of the business, you've got the lending business with BayEquity. You've talked a little bit before about some of the low attach rates in some of the markets, which is how many Redfin buyers are getting a BayEquity mortgage. So obviously, it's a tough business to be in the mortgage business right now. But as things get better and you think about the attach rate, what strategies are you looking at for that aspect of the business? Well, first of all, I'm mostly pleased by the attach rate. I'd tell you where the business is doing well and where it's doing poorly.

Maybe over the past quarter, attach rates haven't increased as fast as they were over the first five or six since the acquisition of Bay Equity. But getting to about a 20% attach rate is great. And we think it can go to 30% just because we have so many large markets that are in that range. To continue driving it, some of it is just sales execution, but some of it is also reimagining how the home buying experience works because so many people start looking for a home

before they know what they can afford and it becomes this game of telephone tag between the broker and the lender and the consumer over where should we be looking and what price range should we be at and so putting those people together and having them work as true partners I think isn't just a monetization opportunity

where we can get two transactions out of the same customer it's also just a way to see the whole elephant for the customer to get the money and to get the house is quite a trick. And pulling that off means that we just have to integrate the two companies better and better. But that deal, I'm just so glad we did it. I know that lenders aren't going to make a lot of money over the next year or two because rates are so high and refi is dead. But the synergy between the two companies, the culture between the two companies is fantastic. Sometimes when you buy a company,

you just think a year later, OMG, what have I done? I feel exactly the opposite. I do that deal every single year. Oh, I love that. So what was it about the two cultures that sort of felt right to you? Well, we just kissed a lot of frogs when we were evaluating lenders that we could potentially buy. And I was the one doing the kissing. And at some point, I became pretty squeamish about it because most of the lenders don't actually care about putting the customer first. They're just trying to turn them upside down and shake as many nickels out of their pocket as they can. And finding somebody who really prided themselves on amazing local service and putting the customer first and recommending the right loan that's right for that family

instead of the one with the highest margin meant that we could in good conscience drive a tax rate because if it's a captive business where you have to recommend that lender, but you actually think the lender's a slime ball who's offering confiscatory rates, that gets hard to ask your sales force to do, especially when your whole mission is to redefine real estate in consumer's favor. So we just found a lender that was a really values-driven lender that was also extremely frugal because every penny you spend is the customer's money. And one that I thought had really good sales instincts. Redfin has become more sales-driven over time. We want to have an incredible website but an incredible sales force too and having bay equity talk to us about

how they motivate their sales people how they manage their sales people has been eye-opening most companies when you buy them start worrying less about the bottom line they start becoming less frugal but bay equity if anything has become more frugal you don't have to tell them to reduce their costs to manage their overhead they do it on their own and that discipline has been fantastic. So, the other company that you bought, I mean, you guys don't do a lot of acquisitions, but you also bought RentPath and you've been developing that whole business. And it seems like it's going great for you. It's headed toward breakeven. That is lovely to see. How else do you see that business evolving and how does it fit with the rest of the Redfin business?

Well, there are two acquisitions that we did. Now we're talking about the second one. The mortgage acquisition was to support the whole transaction and rent or rent path, as it was once called, is really to build a complete housing destination. So we really can't compete simply as a for sale site. The biggest real estate websites are going to offer both for sale listings and rental listings. And so having surpassed all the for sale only websites, the only ones ahead of us are Realtor.com and Zillow.com. We knew that CoStar was also coming into the business with both for sale and rental listings.

So that just becomes the cost of competition. If you want your shot at the title, if you want to go after the biggest prize, you've got to take the chance and put all the listings on your website because otherwise people meet your brand when they turn 35 and they finally have enough money to buy a house,

but they spend the first 15 years of their adult lives on apartments.com or zillow.com or even realtor.com. So one reason that we've been so confident that our traffic is going to keep growing is because we now have two types of listings instead of one on redfin.com. And we felt that RentPath had these rental listings, but didn't understand search engine optimization, didn't understand how to build traffic, didn't understand user retention, all the different ways you can use artificial intelligence to keep people engaged on the site. So we just thought that we had a lot to add to their listings, but we needed their listings. It was a match made in heaven. So the problem with that deal was just how much money the company was losing.

It came out of bankruptcy. It had to do a lot of cost restructuring. And you feel like you can be really patient when interest rates are very low, capital is cheap. But within months of our buying them capital became really expensive and we had to put the hammer down and say, hey, let's bring this to profitability faster. And getting there this year where, you know, last month they were a few months or 50,000 bucks shy of adjusted EBITDA break even. And, you know, they said they're going to get there by the end of the year and it looks like they will. Thank God, because it was just a huge tax on the business. It was draining our coffers. You know, real estate services was throwing off all this money and was paying for other businesses throughout the pandemic.

And now that housing is in a jam, having something that's counter-cyclical that actually can help us in the core business is fantastic. Alright, I will wrap it up with one last question. I'm an investor in Redfin. What do you want me and the other investors to know? Keep the faith! We're busting our tails for you! I know that it's been a wild ride, there have been some ups and downs, but this is a company that has taken share every single quarter that we've been in business until this most recent downturn. And we're going to come out of it stronger than ever. So we just think we've built a much bigger platform with both brokerage and mortgage, with both rental and for sale listings, and investors can reap that return if you could

just give us a little bit of time to power through it. We'll keep powering. Thanks for the support. Thanks, Glenn. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Willard, thanks for listening, we'll see you tomorrow. Thank you.